The Production division of a large company sells 40% of its production to another division of the

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Question:

The Production division of a large company sells 40% of its production to another division of the same company, the Process division.The remainder of the production is sold to external customers.The company considers its divisions as profit centres and allows division managers to choose their customers and their suppliers.Company policy requires that transfer prices for all interdivisional sales and purchases be equivalent to variable costs.

Information about the sales and standard costs for the Production division is as follows:Costs have been determined based on a capacity of 200,000 units.

Process DivisionExternal Customers

Unit Sales80,000120,000

Sales$2,000,000$6,600,000

Variable costs(2,000,000)(3,000,000)

Fixed costs(800,000)(1,200,000)

Gross Profit$(800,000) $2,400,000

The Production division has the opportunity to sell 60,000 units to a new external customer at a price of $50 per unit, which would consequently reduce the number of parts sold to the Process division to 20,000 units.The Process division manager could purchase its actual supplies, 80,000 units, from an external supplier at a cost of $40 per unit.

REQUIRED:

a)Assuming that the Production division wishes to maximize gross profits, should the Production division accept the offer from the new customer? Show all your calculations.

b)Determine whether the company, as a whole, would benefit from the acceptance of the order from the new customer.

c)Assuming that the company allows division managers to negotiate transfer prices, the division managers have agreed on a transfer price of $45 per unit.This transfer price could be reduced by an amount that represents 50% of the additional gross profits that the Production division would earn from the sales to outside customers of the 60,000 units at $50 per unit.In such a case determine the actual transfer price.

d)Independent of the 60,000 units potentially sold to the new customer.Use the general transfer pricing rule to compute the minimum transfer price the Production division would offer to the Process division.